Dilution and Loss of Control of the Shareholder
A share capital increase may modify control of a company and directly affect the equity of its shareholders. What is relevant is that, many times, this occurs without the shareholder perceiving the problem until the transaction has already been formalized.
Some shareholders of Mexican commercial companies are unaware of the serious implications that an increase in share capital may generate in their personal assets, as well as in the control they may exercise in the company. If a shareholder, for any reason, does not participate in the increase, its contribution to the company’s share capital will be diluted.
As a result, such a shareholder would also receive a lower percentage of the annual profits approved by the shareholders’ meeting, and its power of influence in decision-making would likewise be diminished by holding fewer voting rights. [1]
Impact on Investors and Due Diligence Processes
On the other hand, investors considering entering the company through the purchase of stock shares will evaluate, in their due diligence process, that, among other matters, the share capital increases have been carried out properly both legally and in accordance with the bylaws. Otherwise, they may decide not to invest in the company, to retain a portion of the purchase price of the stock shares, or to offer a lower price than that originally requested by the sellers.
Legal Formalities of the Share Capital Increase
Due to such potential effects, the law establishes minimum requirements to be followed so that every shareholder has the opportunity to decide whether or not to participate in a share capital increase.
Certain formalities must be complied with, regardless of whether the cause of the increase is through contributions in cash or in kind, capitalization of liabilities in favor of any of the shareholders, capitalization of retained earnings or stock premiums, etc.
The decision to increase the share capital must be adopted at a general shareholders’ meeting preceded by a call notice signed by the person who is legally and statutorily required to do so and published in the electronic publication system of the Ministry of Economy. The resolution adopted at the meeting regarding the decreed increase must also be published in such a system.
Within a term of fifteen days following publication of the resolution, the shareholders may exercise their preemptive right to subscribe to the new stock shares issued as a result of the share capital increase, in proportion to the number of their stock shares.
Common Error: Prior Waiver of the Preemptive Right
A mistake that frequently arises in practice is to believe that, if there is prior consent from any of the shareholders to waive its preemptive right before the matter is discussed at the meeting, the transaction would be secured. Even if such agreement evidencing the consent is submitted to foreign laws.
Such an agreement could hardly be sustained under the criteria of Mexican courts. This is because the Mexican legal system, in this type of matter, privileges the right of shareholders to participate in the increase under equal conditions and opportunities as the rest of the shareholders, within the terms and timeframes contemplated by law.
Legal Consequences of Non-Compliance
If the foregoing formal requirements are not complied with, the affected shareholder may seek to void the resolution approving the share capital increase, without the need to prove the damage caused to its assets, merely by evidencing that the resolution did not fully respect its preemptive right to participate in the increase under equal conditions as the rest of the shareholders.
As a result, the new capital structure and shareholding participation could also be voided, and even subsequent resolutions, such as share transfers.
In fact, the Supreme Court of Justice of Mexico has previously concluded that the fifteen-day term granted to shareholders to exercise their preemptive right may be extended but not reduced. This demonstrates the importance that our courts place on respecting shareholders’ right to participate in a share capital increase under equal conditions and opportunities. [2]
Final Remarks
Many companies discover that they are facing a problem arising from a poorly planned or executed share capital increase when the conflict is already before them. Therefore, beyond viewing the process as a mere corporate formality, it should be approached as a strategic decision followed by proper implementation.
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[1] There are exceptions to the general principle that each share grants one vote, for example, if limited voting stock shares are issued or stock shares of a different class or series with particular rights and obligations.
[2] Judgment, digital registry number 34850